Expert Opinion: The five retirement mistakes to avoid
Making the right decisions at retirement will make all the difference to your financial security and affect how you pass your wealth down the generations. Stephen Depla, head of office at Brewin Dolphin in Marlborough, discusses the most common mistakes people make at this critical time and how to avoid them.
Retiring too early
It is likely your pension will be near to its highest value when you reach retirement. However, the timing of your retirement could have a significant impact on the level of income you receive.
Generally, though subject to investment content and market fluctuations, the longer you can leave your pension fund invested, the larger the fund will become. This is due to compound interest which Albert Einstein described as “the eighth wonder of the world”.
Making the wrong choice with your pension
When you retire, most pensions do not automatically start to pay you an income. You have to make a choice: either to buy an annuity, which will pay you a guaranteed income for your lifetime, or take income drawdown, where your pension pot remains invested and you draw an income based on how your investments perform.
Annuities suit those who need a guaranteed income and are a lower risk option than income drawdown, where your income may fall as well as rise.
For many people, a combination of guaranteed income through annuities and State or other pensions, combined with some income drawdown can provide the best of both worlds.
Not shopping around for the best annuity
If an annuity is the right choice for you, shopping around for your annuity can improve your income significantly. The shopping around process is known as using the ‘open market option’.
If you are a smoker or suffer from poor health then you may be entitled to an even higher income, via an ‘enhanced annuity’ – it is always worth disclosing health conditions and lifestyle information when getting an annuity quote.
Not taking your full tax-free cash entitlement
After age 55 you may have the option to draw a pension commencement lump sum which is usually 25 percent of the fund value.
If needed this could be used to clear your remaining mortgage, take a cruise or provide a supplementary income to your pension. Otherwise, leaving this money within your pension pot can offer valuable tax benefits, so take advice before you act.
Paying more tax than you need to
Perhaps the biggest tax mistake I see is people not using their Individual Savings Account (ISA) allowance.
Retirement is the time when you will convert your portfolio from pursuing a growth objective to delivering an income and this process is easier and cheaper if your investments are sheltered in ISAs.
ISAs are free from capital gains tax and further income tax and can provide you with a great source of tax free income.
Stephen Depla is head of office at Brewin Dolphin, Marlborough. For more information about Brewin Dolphin’s products and services, click here.